Memorandum

City of Lawrence

Finance Department

 

TO: 

Dave Corliss, City Manager

 

FROM:

Heidi Nelson, Management Analyst

 

CC:

Ed Mullins, Finance Director

 

Date:

April 19, 2007

 

RE:

Other post employment benefits

 

 

 

 

Background 

 

In 2004, the Governmental Accounting Standards Board (GASB) released Statement 45
(GASB 45) which issued a new set of accounting rules concerning health and other non-pension benefits for retired public employees. These benefits, also referred to as “other post-employment benefits” (OPEB), include non-pension benefits such as life insurance, dental coverage and long-term care, as well as retiree health benefits.  GASB 45 strongly encourages public sector employers to set aside funds for OPEB benefits. Instead of a "pay-as-you-go" funding method, employers are strongly encouraged to fully fund OPEB benefits in order to show a more favorable financial statement.

The intent of GASB 45 was to bring governmental accounting standards more in line with private company standards. Though GASB has no power to change how governments fund retiree benefits, it does govern the rules that auditors must follow in providing options on the reliability of governmental financial statements. Audited financial statements prepared according to GASB are scrutinized by investors in state and local bonds and rating agencies that make judgments on the likelihood those bonds will be paid off is required.

 

Analysis

 

GASB 45 requires that an actuarial valuation be conducted to determine the annual OPEB liability.

 

The basis for measurement of annual OPEB cost is the actuarially determined annual required contribution (ARC). The ARC has two components: the normal cost (the value of benefits accrued by active workers during the current year), and the portion of the unfunded liability that is being paid that year.  Although GASB 45 does not require that OPEB obligations be funded, the ARC is the level of employer contribution that would be required on a sustained, ongoing basis to systematically fund the normal cost and to amortize, or pay off, the unfunded liability attributed to past service over a period not to exceed thirty years. 

 

GASB 45 allows for various funding methods, which are as follows:

 

  1. Full pre-funding of benefits – This implies that the City will consistently contribute an amount equal to the Annual Required Contribution (ARC) as defined by GASB 45.

 

  1. Continuing pay-as-you-go funding – This entails no intended pre-funding, and that all future benefits will be paid from the City’s general assets.

 

  1. Partial pre-funding of benefits – This involves contributing an amount which is higher that the pay-as-you-go cost, but lower than the ARC under full pre-funding.  In particular, it is assumed that the City will pre-fund the explicit liabilities of the Plan, but will continue to use pay-as-you-go financing for that portion of the liabilities which are dependent upon the implicit rate subsidy.

 

The table below shows the preliminary determination of the City’s liability for other post employment benefits.  The pre-funded required contribution is less because it would require that the City deposit funds in a trust that would only be used to pay retiree benefits.  The City’s costs are divided into explicit and implicit costs.  The explicit cost is the 20% of retiree health care that the City currently pays.  The implicit cost is the result of health claims for retirees being greater on average than those of current employees.  However, our premiums are not age based and as a result create an additional subsidy for retirees.

 

Preliminary Liability and Contribution for OPEB

 

 

Pay as you go

Fully pre-funded

Pre-fund explicit costs

Projected Liability

9,284,261

4,912,275

7,336,893

Required Contribution

527,203

357,615

452,528

 

Recommendation

 

One way of reducing OPEB liabilities is to make changes to the existing OPEB plan.  EFI will be requested to evaluate changes to the current benefits paid to retirees.  Once the cost of proposed plan changes are known, a recommendation will be made to the City Manager as to which, if any, of the changes should be implemented. 

 

The GASB 45 Committee (made up of members from Finance and Administrative Services Departments) will review the revised plan liabilities and contributions and recommend a method to fund the future liability.  While it is not required that the City pre-fund its OPEB liability, it is required that the liability be disclosed.  Failure to fund the liability will eventually jeopardize the City’s bond rating and burden future tax payers with a larger tax burden.